3/01/2010 @ 3:00PM

The Sovereigns And The Serfs

Bill Gross, manager at Pimco of the world’s biggest bond fund, sees a knock-on effect from governments around the world propping up banks and large corporations with bailouts and bond guarantees: Borrowing rates for governments may soon resemble corporate rates.

If the U.S., the United Kingdom, Germany and others shoulder more and more risk–whether from supporting companies or cash-strapped nations like Greece–”then the credit spreads and yields of these sovereigns should look more and more like the markets that they guarantee,” says Gross.

“The Kings, in other words, in the process of increasingly shedding their clothes, begin to look more and more like their subjects. Kings and serfs begin to share the same castle.”

In his monthly outlook posted on Pimco’s Web site Monday, Gross raises the possibility of this “unicredit” market, as yields on government and corporate debt move closer together. He makes the familiar argument that as governments issue more bonds to survive their financial crises, bond buyers will eventually demand a higher yield to protect against inflation and the risk of the default.

Government efforts can also have the effect of shrinking rates for high-quality corporate bonds. Guarantees from the Federal Deposit Insurance Corp. helped
Citigroup
,
General Electric
and
Bank of America
sell bonds cheaply last year. The sight of troubled financial firms finding investors for their debts encouraged more buyers to return to credit markets, lowering yields for other companies.

So can you cure a debt crisis with more debt? It depends, Gross says. Some countries may succeed in escaping a crisis, but rising borrowing rates place a limit on how much debt they can manage. Greece is the obvious example. Yields on Greek debt jumped last week, and the country scuttled a planned bond offering after rating agencies warned that they would consider downgrading Greece if its budget wasn’t fixed. (See “Bank On A Greek Bailout.”)

Gross says the safest countries are those, such as Canada and Germany, with lower debt burdens and less risk of inflation. The most dangerous can be found in Pimco’s “Ring of Fire,” a circle of countries whose debts surpass 100% of their economic output.

The $7 billion bond sale from the U.K. government on Feb. 23 lifted European sovereign bond sales to $91 billion, the highest volume on record for the first two months of a year, according to data tracker Dealogic.

Gross, who runs Pimco’s $201 billion Total Return Fund, is the closest the bond market has to a celebrity. His place in the bond world is akin to
Berkshire Hathaway’s
Warren Buffett among stock pickers.

Newport Beach, Calif.-based Pimco is owned by the German financial firm Allianz SE.